June 27, 1997

Capital gains change is hot housing topic

By TOM KELLY
The Real Estate Advisor

The latest dip in home loan rates has done little except lull the housing market into a deeper state of vacation doldrums. Potential buyers are saying to themselves, "Why deal with the home search now? Might as well wait until the kids are back in school."

One more drop -- something lower than the mid-seven percent range we now over-confidently believe to be the status quo -- could easily bring another decision to refinance.

So, the hot housing topic of the summer is the proposed change in capital gains tax on the sale of primary residences. The subject surfaced again last week when a mention of capital gains was neatly tucked into an explanation of the proposed $85 billion in cuts passed by the Senate Finance Committee. The bulk of the cash would be washed by a 20-cent-a-pack increase in cigarette taxes and by a $8-a-trip fee on international airline flights from the United States.

What is the latest on home sales and capital gains? And, what, if anything, do these sales have to do with the proposed bump in cigarette tax?

The latest on home sales is basically what was proposed by President Clinton last year: Up to $500,000 for joint filers and $250,000 for single filers would be excluded from the capital gain they received from the sale of a primary residence. The exclusion would be available every two years and would be effective May 7, 1997. (The May date was changed from Jan. 1, and could change again.) If you continued to buy in appreciating neighborhoods, you could repeat the capital-gains cash flow every two years. And, all homeowners would not have to wait until age 55 to pocket a gain and buy down to a smaller, less expensive home. You could exercise this tax-free exclusion at any age.

What was explained during "cigarette week" was the capital gain change for assets other than primary residences. The Senate Finance Committee approved a cut in capital gains taxes, reducing the top rate to 20 percent from the current 28 percent, except for profits from real estate sales, which would be taxed at a maximum of 26 percent. The bill also would provide special reductions in capital gains taxes for small businesses and venture capital.

If there is a surprise in the package, the across-the-board 28-to-20 drop is it. Originally, the basic Clinton proposal contained only the $500,000 home sale exclusion and no relief in other areas.

So, if you sold a stock and faced a gain, the maximum tax liability you would face would be 20 percent of that gain. The maximum tax on real estate, perhaps a small rental property or second home, would be 26 percent. Excluded -- up to $500,000 -- would be a tax on the sale of your primary residence.

"There are a lot questions as to how these proposals are going to be implemented," said Conrad Gehrmann, tax accountant in Arthur Andersen's downtown Seattle office. "And we should stress that they are just proposals. Significant things could change with the stroke of a pen."

That's true, but it's time for some concrete form of tax change. Most analysts believe the shaping and forming is over and the actual package is ready. Historically, tax changes have occurred in August or September but industry followers expect a major move long before Labor Day.

"I'm hearing that we might have a tax bill by the Fourth of July," Gehrmann said. "We should know very soon as to what exactly to expect."

The biggest birthday in housing -- and probably the entire subject of estate planning -- has been number 55. That's the year folks have been able to sell their principal residence and take a tax-free exemption of $125,000 to use any way they want.

The proposed change does away with the one-time, over-55 exclusion. So those folks waiting for "the big 5-5" to tap into needed income would have to wait no longer.

The proposals also would replace existing rules that allow taxpayers to rollover a realized gain when they sell their home for a more expensive one. Taxpayers would no longer have to purchase more expensive homes within two years to get a deferral and avoid paying taxes on the gain. Also, both plans would generally simplify paying taxes on home sales and eliminate the burden of maintaining records on home purchases and sales.

It's important to remember than homeowners in many areas of the country realize no capital gain on home sales. Prices have remained flat for years. In fact, some taxpayers can't fathom the idea that people plan for the $125,000 one-time exclusion.

What was more important to the taxpayers in flat markets was the chance to deduct capital losses on their tax bills. You see, some folks sell for less than they purchased.

If you believe the proposed cuts in the capital gains package are too skimpy, remember: Things could be worse. There's no provision for losses in the present proposals.

Previous columns:

• More lenders willing to take a big gamble on home loans, 06-20-1997
• Look gift houses in the mouth, 06-13-1997
• Affordability not just problem for first-time buyers, 06-06-1997
• Dr. Disaster fixes notorious properties so they can be sold, 05-30-1997
• Today's bride can register for help with the downpayment, 05-02-1997
• Property auctions becoming popular, 04-25-1997
• Ethics and the fast market, 04-18-1997
• Real estate tax tips, 04-11-1997